Good article from Bob O’Brien in Barron’s warning about the dangers of 2X Short funds: Beware of Leveraged Short ETFs.

Its not just the short leveraged ETFs, its all of the leveraged ETFs that have the same slippage characteristic over time.

As anyone who has ever traded them can tell you, they fail to track their benchmark dollar for dollar. This is because they use futures contracts and swaps, and are reset each day. The slippage from their targets us anywhere from 200 to 500 basis points — the longer the time held, the greater the potential slippage. (We use the 2 for 1 leveraged ETFs, both long and short).


“These short ETF funds – and there are 39 of them available – afford investors the opportunity to capitalize on a market decline in a relatively inexpensive, accessible fashion. Like all ETFs, these products are listed, so they trade like stocks. Their associated fees are half – or less – than the cost of comparable mutual funds. And because many of these products use leverage – mainly through the use of swaps – investors can effectively double or triple their exposure to a market decline at no additional cost or risk.

So if you’re betting that the market is going to fall, leveraged short ETFs have a lot of appeal, at least conceptually.

Their performance in the last three months testifies to that appeal. Since the S&P 500 topped out this year on April 23rd, the ProShares UltraShort S&P 500 has gained 20%. By comparison, the S&P 500 itself has lost 12%.”

Note that the ProShares UltraShort S&P 500 (SDS) has about $3.7 billion of AUM, and is the most popular ETF of its kind . . .


Beware of Leveraged Short ETFs
Bob O’Brien
Barron’s AUGUST 23, 2010

Category: ETFs, Short Selling, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

24 Responses to “Beware Leveraged ETF Slippage”

  1. X on the MTA says:

    Ugh, I’ve been trying to explain this issue to people for almost two years now.

    Its one of those simple entropy things. Whoever is offering this product and the inverse needs to be delta neutral. however, they are usually long gamma, which means the funds are short gamma, which is why they get murdered when there is volatility. Take a look:

    Let’s say that we start out with an index at level 50 and the 2x long at share price $100. let’s make some volatility and see how the fund behaves (obv hugely exaggerated so i can illustrate the effects in a few movements, but make yourself a spreadsheet and try it out)

    50 — $100
    45 -10% $80
    50 +11% $97.78
    45 -10% $78.22
    40 -11% $60.84
    60 +50% $121.68
    55 -8% $101.4
    30 -45% $9.22
    45 +50% $18.44
    55 +22% $26.63
    50 -9% $21.79

  2. X on the MTA says:

    in case you are thinking of shorting both sides and making a killing, they are really really hard to borrow and besides, like i said you would end up being long gamma and neutral deltas (and you’d have to rebalance to keep it that way) sooo basically you would be trading a gamma scalp… which you could just do with the underlying if the contracts are liquid enough. similarly, being long both would result in a gamma bleed.

    short both is profitable in times of increasing vol
    long both is profitable in times of decreasing vol

    we did this trade at my firm back in late 2008 and early 2009. it was a a great trade that made a ton of cash until we couldn’t borrow both sides of anything anymore….

  3. stevefest says:

    Just to change course for a bit. Around one year ago I saw Barry R. on Yahoo’s tech ticker and he showed a chart of a bear market (2007-2008?) that fell 56% in 29 months. Then the chart showed a Rebound Rally lasting up to 17 months and gaining 70%. After that the chart once again fell into a “Next Correction” that lost 25% in 13 months. What is your feeling?…..are we now in the “Next Correction phase” My spread sheet shows that we are down 12.28% from the SP 1219 in April. So…do we quickly have another 13% down and then the sideways action that looks like it may last for 5-7 years? Mr. R’s chart ended with that scenario.


    BR: We are about ~80% cash, looking for a move towards 950 on SPX. There also remains a chance of a year end, post-election rally, so we are watching for signs of that.

    As to the broad trading range for a few years: Very possible.

  4. gordongekko00 says:

    Wrong. Leveraged ETFs are the seasoned retail investors best friend. This market appears to be on the verge of tanking so go ahead and try to scare the sheeple but some of us know where the real money is going to be made shortly. I’d rather be trading a leveraged ETF than handing it over to a useless money manager (busy collecting fees) any day.

  5. This is not about a directional call, as I noted above — all of the leveraged ETFs that have this issue — both Long and Short ETFs. Its about the slippage in the ETF vs its benchmark.

    Scare the sheeple ? WTF is that about? Sheeple don’t read this site . . .

  6. mrmike23 says:

    Well, of all the products to trade, I have found that trading TNA v. TZA and mostly closing my trades daily, seems to work pretty good. Sometimes, I let the trade go overnight like last Thursday and Friday with TZA. I use the slow stochastic to give me trading signals–just buy and sell when the 1/2 hour lines cross. I verify direction using the hourly and daily time frame. I trade my own money in a self-directed IRA and find this to be successful as long as I don’t get greedy. I try to make about $200 per day. So far, so good.

  7. gopokes65 says:

    Pretty close to the right answer. Index Universe had a great issue on leveraged ETFs several months ago. Problems come about because of volatility and leverage. The greater the volatility the greater the drift.

    Drift happens even without leverage. Run the math on the single inverse funds. People who whine about leveraged funds typically do not have a basic understanding of how math works. Negative daily compounding is a bitch.

  8. gopokes65 says:

    Basically treat these things as options.

  9. Mr.Sparkle says:

    This has been known for a looooong time. Hell, even I touched on it in a post on my (long since mothballed) blog on January 1, 2009 and wrote a full post looking at the phenomenon with real world numbers on Jan 22, 2009.

    A clever person might even be able to create strategies based on these observations.

  10. louis says:

    “but some of us know where the real money is going to be made shortly”

    Can you give us a hint?

  11. Mr.Sparkle says:

    @louis – Perhaps he’s referring to the compounding phenomenon.

    If you expect a market to go directional without much volatility in the underlying index, these things can blow up in the good way. Of course, if you get the direction wrong and you lack the discipline to cut losses, they can blow up in the bad way too.

  12. It’s not just the ultras. Any of the short ETFs have the same problem. The long ETFs will track the market over time, regardless of vol. All the others will trail the market, and the more vol, the more they’ll trail.

    They’re useful for hedging short-term risk, not useful as a long or even mid-term vehicle, unless you want to be betting on volatility as well as market direction.

  13. Note that when I said “long ETF” above, I meant “long unleveraged ETF.” Those will track the market pretty well. Any of the ultras and any of the shorts (levered or not) will fail to track the market accurately and may do terribly in times of high volatility even if you get the direction right.

    If you want to short something, short it.

  14. MoeB says:

    So everyone knows by now the slippage and all that, so just play them for what they are: intraday hedges or intraday trades.

    If your a daytrader the 2X or 3X are gold, just close out end of day, know the avg intraday range. No matter where they open them at some point they will hit that avg range, pick your side and go, you have to be fast….. as the HFT’rs are all over these. Volatility is king , like mr23 said: don’t be a pig.

  15. NoKidding says:

    Before buying at various times, I plotted the entire time series of SDS, SPXU, TZA, SRS and GLD vs the underlying asset, and even over a span of years they usually stay near target.

    example: SPXU (tripple short I’m in as of 2 weeks ago, thank you very much):

    17-July 2009: 67.27 vs S&P 940

    9-July 2010: 34.08 vs S&P 1078

    1 year change in index: 14.6 pct
    1 year change in 3x short: 49 pct
    ratio: 3.4x

    Minimum ratio over period: 2.1x
    Maximum ratio over period: 4.6x

    Lets not split hairs. If you are buying a 3x short position, and holding for more than a week, you are clearly waiting for an event that amounts to more than a few basis points. I have been sitting on my SPXU for 2 weeks thinking that 950 (or worse) could arrive like a freight train, if not before the elections then shortly after.

    In this situation being scalped even a third of nominal return would be no problem. And unlike a plain vanilla short, there is no expiration date.

    Just my 2 cents.

  16. NoKidding says:

    And likewise EUO. Hard to think the Euro will survive with all that tinfoil squeezing my head. It finally caught up to my earlier unfortunate entry point just yesterday. It would be nice to time it right, but I’m guessing that a major event is in the works this fall, and if the Fed screws up the other side of the bet for a while, so be it.

  17. Darkness says:

    “but some of us know where the real money is going to be made shortly”

    Seeds. :-)

  18. curbyourrisk says:

    Slippage has been discussed ad nauseum over at the ticker forum. Not just by Karl Denninger, but by many of the astute traders over there.

  19. Gator81 says:

    BGZ should be renamed “M80″. If you hold it just a little too long, you’re going to get hurt.

  20. tagyoureit says:

    My name is tagyoureit and I haven’t used leveraged ETFs for 27 days. ;)

  21. Darkness Says: August 24th, 2010 at 8:46 am

    “but some of us know where the real money is going to be made shortly”

    Seeds. :-)


    way to bring the issue to light..

    “…A federal bankruptcy judge in Columbia, S.C., has accepted an offer from Blackstreet Capital, a private equity firm in Chevy Chase, Md., to purchase financially troubled Park Seed Co., a 142-year-old seed company in Greenwood, S.C. As part of the sale, Blackstreet has agreed to maintain the seed company’s 150-person workforce and to remain in Greenwood for at least 3 years. Blackstreet would have to pay each the bankruptcy estate, the state and Greenwood County a $500,000 penalty if it relocates sooner. The seed company’s creditors, which include Ball Horticultural Co. and C. Raker and Sons, indicated they were pleased with the offer.

    Pictured: Private equity company Blackstreet Capital has purchased Park Seed Co. for $12.8 million.”

  22. Sunny129 says:

    My 2 cents

    “Their daily reset feature makes them ill-suited to many buy and hold strategies.” TRUE

    ..because these products are rebalanced each trading day, they reset at essentially zero. TRUE

    “These aren’t securities that work in a trendless market.” DISAGREE
    Looks like I am loaner here, comfortable using these using these hedging vehicles. But I use them in conjunction with their options! I have been using since 2008 – worked wonderfully, 2009 – got shafted MAINLY b/c Perception triumphed the Reality plus free market ceased to exist. But this year I adopted different strategy as described below:

    You can make use of these so called ‘drawbacks’ including ‘resetting’, if you use THEM (1x,2x and 3x long/short ETFs) along with their OPTIONS (call/put) BOTH sell(covered call and cash covered put to match that inverse ETF!)and also buy side! If covered call goes up and called, your put short is in gains( this is more likely in slow down trending market like NOW!).

    If your short gets assigned, your covered call + assigned ones can be resold. Latter is the real risk, if the Mkt keeps going up! But again after going up 60%+ within a year, what are the chances of this happening again?

    With time decay favoring the seller, with an insurance against all the time and the rest of my portfolio is long including Div/income(stocks, Bonds and ETFs)producing vehicles + Blue chips with covered calls.

    With range bound Mkt trading between 9K-11K, they have produced enough NET gains. (trade online, with discount traders – less than $5 per trade). Most important I feel I am in control, secure and confident irrespective of the direction of the market, ever since I started investing( self educated) since 1982. They work for me just fine!

    If you employ them without investing with their OPTIONS with hedging, then you are exposed to all the hidden drawbacks as mentioned above. So if you don’t know options, stay out of these inverse ETFs.

    Is any one else has a say on this strategy?

  23. Sunny129 says:

    Just an additional info re my trading on these inverse ETFS:

    I sell/ buy (covered call and cash covered puts) in DTM only at least 2-3 months and beyond. B/c of exremly limited liquidity one has to be selective. I am using TIME decay in my favor b/c slippage, resetting characteristics of these vehicles!

    I use gz/bgu, sso/sds, ddm/dxd, tyh/typ, tna/tza. erx/ery, upro/spxu, czi/czm etc

  24. takloo says:

    direxion has done a reasonably good job of educating investors through their site… the key is that leveraged ETFs offer DAILY leveraged returns… anything other than DAILY and the returns will depend on the volatility due to the constant leverage factor and daily rebalancing necessary to maintain leverage…